Paul Krugman asks: If we wake up in 2012 and find ourselves with $9 trillion in government debt, are we any worse off than if we wake up and find ourselves with zero government debt? Assuming that all of our government debt is held domestically (so that we don't have to slave away for foreigners), and assuming that we don't default on our debt (which causes economic disruption), the answer is "no." Some people (creditors) are better off and some are worse off, but overall it's a wash.
Nick Rowe asks: If, starting now in 2012, we rack up some more debt over the next decade, will that make our descendants in 2042 worse off than they would be if we didn't rack up any more debt? Rowe's answer is "yes." To show how this works, Rowe makes an "overlapping generations" model where all goods are perishable and debt temporarily grows faster than GDP. In the model, the government uses debt to give extra consumption to the older generation, then taxes the younger generation to pay back the debt. Voila! A burden is imposed on the young.
But see, here's the interesting thing about Rowe's model: the government doesn't need to use debt to impose this burden on the young. It can achieve exactly the same result with zero debt, just by taxing the young directly and spending on the old (i.e. a Social Security system with unsustainably large contributions). In Rowe's model, debt is just an accounting system that keeps track of how much consumption has been transferred from the young to the old. But the debt itself doesn't really matter; only the consumption transfer matters.
So I think this tells us something important about debt in the real world. What matters is not debt, it's intertemporal choice. The important question is not how much debt we rack up, but whether we want to move consumption from the future into the present or from the present into the future.
In the real world, the way we move consumption around through time is through investment. In Nick Rowe's toy model there is no investment (because all consumption goods are perishable), but in the real world, the way we move consumption into the future is by investing in productive assets, like buildings or machines or education or ideas. The way we move consumption from the future to the present is by reducing investment and consuming more today.
So when the government takes out more debt, does it move consumption from the future to the present, or from the present to the future? The answer: It depends on what the government spends the money on!!!
("Aha!", you say at this point. "But investment = savings, and debt is negative saving, so more debt always means less investment!" And here is where I invoke Krugman: For the government to borrow money, someone has to save money by buying the government bonds. Objection overruled!)
It depends on what the government spends the money on. If the government borrows money and then invests it in productive assets - building or repairing infrastructure, researching new ideas, improving schools - and if those productive assets have real rates of return that exceed the rate at which the government borrowed, then the debt (or rather, the debt-financed spending) transferred consumption from us to our descendants, not the other way around. And note that this is true whether the government borrows domestically or from foreigners. But if the government spends the money on consumption - for example, buying everyone in the country a birthday cake - then the debt-financed spending has transferred consumption from our descendants to us...it has imposed a burden on future generations.
Now, it's also true that the private sector can act to neutralize some or all of this intergenerational consumption transfer. If increased public debt is spent on consumption goods (birthday cake), then the private sector can choose to invest more of its own money in productive assets (e.g. office buildings or trucks), thus negating the burden imposed on the future generations. To what degree that actually happens is an open question.
But the basic point is this: When asking whether running up our debt will impose a burden on future generations, the key question is what the government will do with the money it borrows. I personally believe that the U.S. is currently underinvesting in the kind of productive assets that only the government can cheaply create - roads, bridges, electrical grids, broadband infrastructure, and basic research. That means that if our government borrows to invest in those things, it will be doing our grandkids a favor, not imposing a burden.
When you say, "It depends on what the government spends the money on," I think your combining two fundamentally distinct questions. First, given a potential investment X, should the government do it? Second, if the government does it, how should it be financed? The first question has nothing to do with debt. If the NPV is positive, the government should do the investment. Once the government has decided to do the investment, it can finance it with taxes, or it can finance it with debt. Compared to the former, the latter places a burden on future generations, no matter how good the investment. (Of course I'm assuming the NPG condition, which I don't actually believe holds in reality, but that's a separate issue.)
ReplyDelete"Compared to the former, the latter places a burden on future generations, no matter how good the investment..."
DeleteNooo! This is exactly what has just been shown to be false.
Andy:
ReplyDeleteI don't think you're right on this one. If present consumption is the same in the tax-financed and debt-financed cases, and if the same positive-NPV investment is made, then future consumption will be the same in both cases, in accordance with the intertemporal budget constraint.
I'm assuming that the marginal propensity to consume out of disposable income is greater than zero, so consumption today will be higher in the debt-financed case. As Nick would say, unless you believe in Ricardian equivalence....
ReplyDeleteIsn't the real difference between Rowe and Krugman that Rowe is assuming a situation in which debt financing grows faster than GDP while Krugman is assuming the opposite? Krugman makes this clear in his official Monday column, I think.
ReplyDeleteAnd Krugman's go-to example of post-war growth rendering war debt irrelevant is, I think, pertinent to your argument: war spending might just be the ultimate in present consumption - actively destroying huge amounts of expensive infrastructure - but the post-war economic growth still rendered the burden imposed on future generation irrelevant.
Andy:
ReplyDeleteMaybe...or maybe the public goods will be a complement to private capital, causing the private sector to save more, reducing current consumption (and raising future consumption) even further. Didn't Brad DeLong make this point on Twitter earlier today?
Bsc:
Well, debt is growing a LOT faster than GDP right now, and has grown faster than GDP in most of the years since 1980.
Yes, we paid down our debts after WW2, but a lot of wars are just waste...take the Iraq war for instance. If we had spend that money repairing our infrastructure...
"...maybe the public goods will be a complement to private capital, causing the private sector to save more, reducing current consumption..."
ReplyDeleteBut this is irrelevant to the question of how the investment is financed. If the public goods complement private capital, then the decision to to undertake the public investment will, of itself, result in lower current consumption. If you decide to finance it with debt instead of taxes (assuming MPC>0), this will result in higher current consumption. Which effect predominates is ambiguous, but the effects come from fundamentally distinct decisions, and the argument is only about the second decision.
(Here I think we're both assuming full employment, which I suppose we might as well.)
Andy:
ReplyDeleteI consciously refrained from any statement regarding which assumption is right (faster growth of debt or GDP). My point was merely that the distinction between Krugman's argument and Rowe's argument lies here, rather than in Noah's discussion of whether the debt is used to finance investment or consumption. Krugman clearly argues that even debt used to finance consumption (i.e. war) is irrelevant to future generations if the economy grows fast enough.
But, FWIW, I don't think your point is a good one. Yes, in the 1980's debt soared - and was subsequently made irrelevant by economic growth in the 1990s. Yes, absolutely we would be better off if we hadn't run up more debt to fight the Iraq war, but that's irrelevant to whether it is appropriate to run up more debt now for economic stimulus. If we posit that the net effect of government into the indefinite future will be growth of debt faster than growth of GDP, then sure - running up more debt is a bad idea. But if we posit such government then we're stuck making circular arguments: debt is bad if we define debt as unsustainable.
Krugman thinks that consideration of the full historical record should lead us to conclude that debt is, in fact, sustainable and that government does not inherently lead to growth of debt faster than growth of the economy. Maybe he's wrong, but his argument must be addressed from the longer historical record rather than just a few decades.
Oops - my last comment should have been addressed to Noah, not Andy. Sorry
ReplyDeleteAndy:
ReplyDeleteIf the government can predict the effects of debt and taxes on consumption, there is a whole continuum of ordered pairs of government investment and government debt that will yield any desired expected path of consumption. So your contention only has meaning if you first fix the size of the government investment and then ask how to finance it. My whole point in this post is that you can't just look at the amount of new debt and know how much of a burden fiscal policy is imposing on future generations...you must also look at the amount and rate of return of government investment. So I think your contention illustrates the truth of my main point.
bsc:
ReplyDeleteKrugman makes two separate arguments. If you read his op-ed, he explicitly enumerates them. "First, families have to pay back their debt. Governments don’t..." That argument I agree with, and I don't think Nick Rowe would necessarily disagree. "Second...an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves." This second argument is (more or less, though it's complicated) wrong. It's true that the first argument (if you find it convincing) makes the second one academic, but Krugman makes the second one anyhow. My policy recommendations today would not depend on the validity of this second argument, but I still think it's interesting, in part because not everyone would find the first argument as cogent as I do, and in part because Krguman seems to be failing to acknowledge the counterargument.
"If we wake up in 2012 and find ourselves with $9 trillion in government debt, are we any worse off than if we wake up and find ourselves with zero government debt?"
ReplyDeleteThis strikes me as a silly question, at least the way you seem to interpret it as "all other things equal." Of course all other things won't be equal, because the debt is evidence that something else has happened, namely more consumption than if the expenditure had been financed with taxes. (The situation is complicated by unemployed resources, and I agree that, in today's particular case, the extra consumption was a good thing and probably did little or no harm to future generations -- but see my discussions with Nick and AdamP on Nick's blog: the debt could also be evidence of higher lifetime disposable income for the current generation, which could cause their cohort to consume more in the future also, when there may not be unemployed resources, thus taking consumption away from a later cohort.)
"...your contention only has meaning if you first fix the size of the government investment and then ask how to finance it."
But again, the correct decision about how much investment to do does not depend on how you intend to finance it. The government should fix the size of its investment at the point where the marginal NPV is zero.
"...you can't just look at the amount of new debt and know how much of a burden fiscal policy is imposing on future generations"
That depends on how you define fiscal policy.
Ultimately I agree with you on the substance, but I still think Krugman is making a fallacious argument.
"The important question is not how much debt we rack up, but whether we want to move consumption from the future into the present or from the present into the future."
ReplyDeleteHistorically, our ancestors sacrificed for the benefit of future generations. That is how capital accumulates.
Under Christianity, which was the dominant faith of our ancestors, a basic idea was that self-sacrifice now would lead to future rewards, both for the individual (after death) and for the world as a whole (a new heaven and a new earth).
You can doubt whether they received their reward(we will never know) but there can be no doubt that their sacrifices are the foundation of science, capitalism, and democracy.
A terrible human prices was paid to build the modern world. Capital itself is a kind of stored servitude. It is the accumulated crime and sacrifice of centuries, plus interest. To undo that process now is about the biggest sin I can think of.
One wild card here is the possible finiteness of some of our natural resources. I know economists like to pretend that everything is substitutable, but we seem to me to be in a novel era with regard to our climate and our stock of easily recoverable fossil fuels. Anyway, I'm enjoying your discussions...
ReplyDeleteYOU SAID:
ReplyDeleteFor the government to borrow money, someone has to save money by buying the government bonds. Objection overruled!)
WRONG. If the savers are foreigners using their tarde surplus dollars to buy our bonds with then the interest all goes back overseas (unless we default on debt held by non-US holders like Iceland did in 2008).
Does it make any difference within this argument to ask what types of investments private capital would make in the same time frame and what the expected returns would be there?
ReplyDeleteIf the private investment would fund innovations such as the invention of the PC, the Internet, biotech, etc., then clearly these are positive uses of money, then it is probably best to fund (smart) government / infrastructure investment with debt, and use the future payoffs from both types to fund the infrastructure.
If, however, the major force in play for private investment is speculative, then I think the argument flips. Private investors will always follow the highest expected return, whether it's in a real innovation or just a bidding-up of housing, securities, commodities, or whatnot. This is the process that fundamentally shapes asset bubbles, because those with serious capital usually can get out in time when the bubble pops, and wind up with a huge return anyway.
If this is the current model of private investment, then it's better to pay for the public investment through taxation.
The hard question, of course, is who makes that call and how...
But again, the correct decision about how much investment to do does not depend on how you intend to finance it. The government should fix the size of its investment at the point where the marginal NPV is zero
ReplyDeleteHmm, I don't think this is right...if the type of financing matters, then the act of financing can affect NPV...
"if the type of financing matters, then the act of financing can affect NPV"
ReplyDeleteThat's true if there are liquidity constraints (so that the appropriate discount rate is higher for tax-financed investment). But when you start introducing realistic stuff like unemployed resources and liquidity constraints, it becomes a whole different argument. In such a world, debt is not necessarily a burden in any case, even if it's used to finance pure transfers.
That's true if there are liquidity constraints (so that the appropriate discount rate is higher for tax-financed investment).
ReplyDeleteYes but not only that. If the type of financing affects private consumption/savings decisions, then those altered decisions may affect the thing being discounted.
But when you start introducing realistic stuff like unemployed resources and liquidity constraints, it becomes a whole different argument. In such a world, debt is not necessarily a burden in any case, even if it's used to finance pure transfers.
Yes. In which case debt itself becomes a public good. But I thought that that was rather far afield for this post... ;)
Isn’t the key to Nick’s model that he assumes the debt is paid off with taxes? Whether the taxes are payable in apples or dollars, somebody somebody in the final generation of that sequence is going to be worse off.
ReplyDeleteKrugman doesn’t assume that, does he?
He implicitly assumes taxes aren’t required. So long as the bonds are outstanding, the government’s liability is the private sector’s asset, the latter whether expressed in apples due or dollars due. That’s a stock of private sector net financial saving that remains outstanding. Taxes levied to pay down that debt, whether in apples or dollars, eliminate that saving.
The same would hold if the currency becomes machines instead of apples.
And I think Nick’s argument would hold for machines instead of apples.
That all applies to the debt.
What applies to the investment in the case of machines is a separate matter. That’s not involved in assessing the burden of the government debt per se.
It is involved in assessing the burden of the government’s own net financial position, which includes the effect of its assets and its investments in addition to its debt. That’s the unaccounted for government equity position (usually negative equity).
Andy writes: "Once the government has decided to do the investment, it can finance it with taxes, or it can finance it with debt."
ReplyDeleteYou need to look at the government's funding on a consolidated basis. You cannot be acceding to a unit of debt just because you can pair it with a unit of investment, at least not while there is any consumption spending at all.
The laws of physics are of supreme relevance here, not any of the laws of economics. There is just no way a “burden” can be endured or blood, sweat and tears can be expended in 2030 that enables a bridge to be built in 2012. Steel produced in 2030 cannot be used to build a bridge in 2012.
ReplyDeleteWhether the bridge is a good or bad investment is irrelevant. Whether the bridge is funded by tax or borrowing is also irrelevant.
The only way Nick Rowe gets round this is with the very unrealistic assumption that today’s oldies somehow get today’s youth to work extra hours and buy debt off oldies. We’ve had a big increase in govt debt in recent years, but I haven’t noticed a mad scramble by youngsters to work extra hours so as to purchase this debt.
Okay, lets talk physics (and economics). Capital is the accumulated value/wealth of civilization. It is the legacy we leave posterity. Left to itself, capital always deteriorates with time (e.g., bridges and school buildings decay). There must be constant investment with an ROI at least equal to the countervailing decay/entropy rates to maintain that capital. Those investments can be made by the government or by private institutions or individuals. Alternatively, either of these can spend their money and effort on consumption. It is the effect of today's balance of consumption versus investment that affects the capital the future generation inherits. That is the tangible temporal wealth transfer. It is the current generation's responsibility to maintain if not to improve the nation's net capital. Excessive consumptive spending, whether by the government or by the private sector, fails this test and cheats future generations. If deficit spending is financed by the government through taxes, it creates a pressure to increase tax rates in the future that will ultimately catch up with some future population incurring an increased involuntary tax indemnity to the federal government--that is both a tangible financial burden and an intangible loss of liberty in their discretion to spend that fraction of their own money. If government deficit spending is financed by public debt, then at least it is being imposed upon volunteers who are content to accept those government securities interest rates in exchange for the loss of liberty they incur in temporarily parting with their money. The larger question, though, is the opportunity cost of giving today's money (whether collected by public debt or taxes) to a big government and living with how the political sausage factory spends the money on vote-buying schemes versus what the private sector would do with that money if they kept it. Which approach better spends money on increasing capital and leaving a better inheritance for future generations--government bureaucrats and politicians spending other people's money, or individuals and businesses and entrepreneurs spending their own money? Adam Smith and a host of others from Austria to Chicago will argue and produce much evidence that a democratic government will tend more toward consumption for the immediate gratification of re-election, while the private sector will tend more toward investment for future prosperity and welfare of their children and business.
DeleteNoah:
ReplyDeleteThe typical uneducated farmboy who reads the New York Times (sorry, joke) probably believes two things:
1. The national debt is a liability and a burden on future taxpayers.
2. The government bonds backing my pension plan and bank balance are an asset worth their market value.
Then Paul Krugman comes along and tells them not to worry about the burden on future taxpayers, because it isn't really a liability.
It would be rather fun to watch the reactions of the NY Times readers if PK also added "By the way, this also means your pension plan and bank balance are worthless, because those bonds you think you own, or your pension plan or bank thinks it owns, aren't really an asset".
They would go ape. "Hey, I paid good money for those bonds, and I damned well want to get my money back from the future taxpayer!"
Ralph: Nope. I showed in my example how to get apples travelling back in time ;-)
Bsc: if you read Paul Krugman's earlier posts, he is explicitly talking about a bigger debt implying a future tax increase. That's why he is careful to mention the distortionary effect of higher tax rates on incentives.
Noah: good post.
But you can move resources from future generations to the current generation, in a chain, even if you can't make individual apples travel in time, and even if there is no investment.
"...and debt grows faster than GDP."
That needs a tiny edit. It should be: "...and debt would grow faster than GDP if the government didn't raise taxes."
Andy has a good point in his first comment.
Nick:
ReplyDeleteThanks for dropping by!
But you can move resources from future generations to the current generation, in a chain, even if you can't make individual apples travel in time, and even if there is no investment.
Of course you can! As in your model. But with durables you can do it a lot more. And productive durables are the method by which debt-financed spending can boost future consumption, which is why when I shifted to talking about the real world, I started talking about investment instead of transfers.
"...and debt grows faster than GDP."
That needs a tiny edit. It should be: "...and debt would grow faster than GDP if the government didn't raise taxes."
I meant, "and debt grows faster than GDP for some period of time."
Andy has a good point in his first comment.
Yes, but it's tangential! The farmboy reading the New York Times wants to know the answer to one of two questions:
1. Does the currently existing national debt represent a burden on me? (Krugman answers this one.)
2. If the government borrows more money, will it impose a burden on future generations? (You and I answer this one.)
Andy asks: "Holding spending constant, does debt finance impose more of a burden on future generations than tax finance?" And the answer is: "Under certain conditions, yes." But I think that is not the question that the hypothetical farmboy is asking...
Noah: I used this to help me write a response to Matt Yglesias:
ReplyDeletehttp://worthwhile.typepad.com/worthwhile_canadian_initi/2012/01/matt-yglesias-and-spilt-milk.html
I can't figure out how to post a comment for Matt, so he sees it.
Nick:
ReplyDeleteI sent it to Matt.
A liter of milk? Damn! Did you try to chew a whole habanero pepper or something? I think my friend Jim drank a liter of milk after trying to do that...
Thanks Noah!
ReplyDeleteI couldn't use "apples", since I wanted to use the spilt milk metaphor! So I had to switch to milk.
Paul Krugman is probably getting sick and tired of this topic. But I really wish he would address this critique. All his last post is saying is that abolishing the existing debt doesn't make us richer. True, and nor does crying over spilt milk, but that doesn't mean it's costless to spill more milk.
Agree.
ReplyDeleteTo go on a tangent, what I wish most of all is that everyone would start having a high-level discussion about public goods (meaning public investment in partially nonrival capital), and whether it is sufficiently high in the U.S. Instead, everyone's talking about stimulus. But if we're underinvesting in things like road repair and research, then boosting public investment would be a supply-side boost AND stimulus, so it would satisfy everyone (except maybe hardcore libertarians who dislike the fact that public goods exist).
If the government increases the deficit and uses the proceeds to lower the long-term unemployment, wouldn't the future generation be happy to pay higher taxes just to improve the livelihood of their grandparents?
ReplyDeleteNick, I’ve just re-read your 28th Dec post on “Worthwhile Canadian Initiative” in which you deal with apples. Unless I’ve completely misunderstood, you say that youngsters in one generation pay for the consumption of apples by oldies in that generation. Same for the next generation.
ReplyDeleteIf that system can be imposed, then I agree that a burden can be passed from one generation to the next. But I just don’t think that that system applies to the real world to any great extent. It DOES apply in that youngsters buy bonds and then sell them in their retirement. But if government bonds did not exist, people would have alternative arrangements to fund their old age: they’d use other assets and/or go for “pay as you go” pension schemes. And the two latter have a similar “getting youngsters to pay” effect. Thus an INCREASE in government debt will not in practice INCREASE the burden passed on to youngsters. Those planning their pension arrangements may switch to some extent from using “other assets” or using “pay as you go” to using government bonds. But the overall burden on youngsters will remain about constant.
Alternatively, I may have completely misunderstood what you are saying about apples. And in that case I assume several other people will have misunderstood as well. So perhaps you could set out the idea again. (Hides behind desk.)
This whole discussion is detached from reality.
ReplyDeleteQuoting Krugman: "Some people (creditors) are better off and some are worse off, but overall it's a wash."
ReplyDeleteDoesn't this "we owe it to ourselves" argument rest on the assumption that a dollar lost by a poor man is offset by a dollar gained by a rich man? Who really believes that?
It is astounding that so much ink is spilled on the blogosphere in "how many angels can dance on the head of pin" debates when a look at the long-term data shows that interest rates have generally been below nominal GDP growth rates over nearly 200 years for which data is available for the US. Short-term interest rates have actually been well below GDP growth rates except few episodes. And I am talking about interest rates from the Homer and Scylla data, which are broad composites. That is government borrowing rates being below nominal GDP growth rates is the norm rather than the exception. And we all know that under this condition, government debt need not be a burden.
ReplyDeleteThe data are available from www.measuringworth.com.
[Disclaimer: I know I'm in an intellectual slump and I'm an old man to boot. So feel free to disregard.]
ReplyDeleteNoah writes: "But the basic point is this: When asking whether running up our debt will impose a burden on future generations, the key question is what the government will do with the money it borrows. I personally believe that the U.S. is currently underinvesting in the kind of productive assets that only the government can cheaply create - roads, bridges, electrical grids, broadband infrastructure, and basic research. That means that if our government borrows to invest in those things, it will be doing our grandkids a favor, not imposing a burden."
Yes, I agree. And at the very least we owe it to our kids and grandkids that they be able to enjoy the same standard of living we have, which our parents and grandparents bequeathed to us.
But isn't the over-riding issue today (as it effects our children and grandchildren) the distribution of income? Or, rather, the distribution of consumption, since it is consumption, not income, that really counts in the end?
There are trade-offs between the size of total consumption and the distribution of consumption. Somehow that issue is being ignored, including the advantage of a graduated expenditure tax (as proposed by Fisher) over a graduated income tax in so far as the trade-off between equity and the future growth of the economy are concerned.
But who even knows what Fisher's proposal was, or why computers and the Internet have brought it within the realm of feasibility?
How about the advantage of wage subsidies over minimum wage laws? I assume every economist understands that, but why aren't we discussing it as an alternative to food stamps, for instance?
I think I know why. Because in the back of our minds we think it is not practical to raise the revenues to finance wage subsidies across the board. But that comes back to a graduated expenditure tax again.
Free trade, in theory, benefits us all. But again the important reality is its effect on the distribution of income. So again the advantage of GET (graduated expenditure tax) over protective tariffs is the real issue we ought to be discussing.
What is the missing ingredient in modern economic science? The axiom of equality: that a dollar is worth more to a poor man than a rich one, other things being equal. This is a moral axiom, of course, not an empirical one. But with it a lot of empirical conclusions can be drawn in the realm of policy.
Our republic is founded on the axiom of equality. Deep down we all know that. It is inscribed in the Declaration of Independence and the preamble to the Constitution. The alternative is nihilism.
*Sigh* The buildup of debt saddles future generation with costs because debt that is not, in the fullness of time, self-liquidating represents imbalance, and a profound buildup of debt such as we have accrued implies profound imbalances that impose profound costs.
ReplyDeleteIn all this back and forth, it is interesting to me that no one has pointed out that the rise of debt perfectly coincides with the rise in international imbalance and the rise in domestic income inequality. That coincidence is not coincidental.
In fact, the last time income inequality was remotely as imbalanced as it is today was the late 1920s, (also a time when speculative international flows, notably into German War reparations were also distorting asset prices and decisions). That too is not coincidental (nor was it considered to be before Milton Friedman delivered the coup de gras to the wisdom our ancestors who lived through The Big One tried to pass on).
Note that these empirical facts (to say nothing of basic intuition and all manner of historical allegory) imply that rapid debt growth sustains unsustainable economic relationships, in so doing getting the wrong capital equipment built in the wrong places, exploiting the wrong resources at the wrong times, sending students into the wrong courses and workers into the wrong industries, acclimating people to the wrong lifestyles, etc. etc. etc.
Note also that when the whole charade blows up, as it must, inevitably, that the collateral damage tends to include the political order, with dire historical record of potential ramifications (hence why one now renowned hedge fund manager has taken to saying that the only things worth investing in are "guns and gold". It's the first part that's more worrying than the second, not least in light of his track record.).
Finally, note that the precise monetary policy that both Keynesians and Monetarists have been commending to us since the synthesis, and not least since Friedman, is the exact policy to arrive us all at the point of no return:
Supporting asset prices and lowering borrowing costs at every hiccup in the market, (amazing how quickly they accept which is the dog and which is the tail when the market gets a little soft), only insures the severe exacerbation of imbalance, not least when coupled with a laissez faire attitude to regulating financial intermediaries.
In fairness to the Keynesians, at least they are on board with the need to tightly regulate intermediaries, and it's worth noting that with fiscal policy there is the potential to rectify some of the imbalances, (for example, it is conceivable that infrastructure investment could improve American competitiveness).
Although, in my view, neither offers much promise in light of the limitations (and corruption) of central planning and of the forces that are unleashed when one manages the business cycle in a changing world. Schumpeter's beating heart of capitalism needs to beat.
PS For the economists on this blog that would like to know why amateurs and the heterodox insist on sticking our unqualified noses into your debates, I'd love it if they could explain why the above questions are not central to this discussion. I'd love it even more if they could explain why amateurs and the heterodox consistently have more insight into future events than orthodox economists who have been perfectly wrong as long as I've been paying attention.
PPS It's worth noting that Brad Setser who knows a thing or two about this stuff is far less sanguine about foreign financial flows than Krugman appears to be. Back when he was blogging he tended to note the curiosity whereby economists would talk about (and model) capital flows as if they are based on welfare optimization notwithstanding their being dominated in practice by a few 'official' institutions. Things that make you go 'hmmm' indeed.
@Ralph Musgrave
ReplyDelete"...they’d use other assets and/or go for “pay as you go” pension schemes..."
It's true (as Noah argued in the main post) that "pay as you go" pension schemes can have the same effect as government borrowing, but I'm not so sure about "other assets." Since the "other assets" aren't issued by the government, they are presumably liabilities of someone in the private sector. Nobody is made significantly richer by the creation of those assets, so nobody increases their expected lifetime consumption when the assets are created. The thing about government bonds is that someone does become richer when they are issued (assuming Ricardian equivalence doesn't apply), so total current consumption goes up. If the economy is at full employment, then the increase in current consumption has to be made up by a decrease in consumption by some later cohort. (If the economy is not at full employment, the situation is complicated, but Nick has convinced me that at least part of the increase in consumption will normally be offset by reduced consumption by a future cohort, at least under standard life cycle assumptions.)
Noah,
ReplyDeleteGreat post as usual.
For a given positive NPV public investment, debt as opposed to tax financing can clearly mean lower consumption for our grandchildren, in that at full employment it would be expected to crowd out private investment. I mean, nonetheless, I think the Krugman point was fine, just to say to laypeople, hey, it's not like in the future the entire debt will be a total loss to our grandkids, as if it's paid 100% to outsiders.
"I personally believe that the U.S. is currently underinvesting in the kind of productive assets that only the government can cheaply create..."
I strongly agree. Have you seen, "Measuring The Social Return To R&D", QJE, November 98, Jones and Williams:
"Is there too much or too little research and development (R&D)? In this paper we bridge the gap between the recent growth literature and the empirical productivity literature. We derive in a growth model the relationship between the social rate of return to R&D and the coefficient estimates of the empirical literature and show that these estimates represent a lower bound. Furthermore, our analytic framework provides a direct mapping from the rate of return to the degree of underinvestment in research. Conservative estimates suggest that optimal R&D investment is at least two to four times actual investment."
@Andy Harless,
ReplyDeleteYou say “the increase in current consumption has to be made up by a decrease in consumption by some later cohort.” I agree with that, in that (as I said above) Nick’s idea works where youngsters are made to sacrifice consumption for the benefit of oldies LIVING AT THE SAME TIME.
However, if you are saying that an “increase in consumption” by the entire population in year X can be “made up by a decrease” in consumption by the entire population in five, ten or twenty year’s time, then I don’t agree. Remember that one of the assumptions in Nick’s original apple economy was constant full employment. In that scenario, “total current consumption” (to use your phrase) can't to go up in any particular year (Else inflation ensues.)
That leads to another part of your comment where you seem to assume that because fewer government bonds are created, there must be less of a rise in private sector net financial assets and thus less “expected lifetime consumption” to use your phrase. Again, that conflicts with Nick’s full employment assumption.
And that in turn raises a question which may puzzle you and/or others, namely how to expand government debt without having any effect on GDP. Well it’s easy: have government do a standard Keynsian “borrow and spend” exercise, while counteracting the stimulatory effect of that by borrowing even more (or raising taxes) and doing nothing with the relevant money (i.e. extinguishing it). Abba Lerner, the founding father of MMT was happy with the idea of creating money and spending it, or reining in money and extinguishing it when appropriate. He was right, I think.
God this is complicated. Time for me to take another anti-nervous breakdown pill.
Krugman is still wrong.
ReplyDeleteBecause even with a printing press, part of that government debt is payable by future generations.
See Buchanan:
http://www.econlib.org/library/Buchanan/buchCv2c15.html
Even in a Keynesian world, finance still holds.
@Ralph Msugrave
ReplyDelete"...where you seem to assume that because fewer government bonds are created, there must be less of a rise in private sector net financial assets and thus less “expected lifetime consumption” to use your phrase. Again, that conflicts with Nick’s full employment assumption."
No it doesn't. There is less expected lifetime consumption by the current cohort (the currently young, in this case), but the sum total of consumption by all cohorts at any given time is the same. That means there must be more expected consumption by another cohort, which indeed there can be, because the currently young will later be old, and there will be new young people who can consume more than they otherwise would have.
If "more debt always means less investment", that blasts a big hole in our society's business model. For generations, businessmen have borrowed money, invested it and, in many cases, done quite well out if it, paying back the loan and earning a neat profit. Somehow or another, the debt doesn't seem to cancel out the investment. I assume this aphorism was from a fresh water economist, either that or a gibbering idiot.
ReplyDeleteLook around and consider what our ancestors have left to us. In many cities, there are large libraries built of granite and marble and filled with books. There is an interstate highway system and hundreds of thousands of miles of railroads. There are public schools, and hospitals. Imagine if we didn't have any of these. We'd be Sudan, or Haiti, or Bangladesh. Think about the labor and materials that went into these investments. All that is ours to use--all we have to do is pay enough taxes to pay for the upkeep, and update it as needed for our kids and grandkids.
ReplyDelete